Hi All, Interesting article on prop shops in today's Trib. Enjoy! -- Prop shops' pivotal role Proprietary trading firms, which deal in options and futures with their private funds, are relatively anonymous but influential By Joshua Boak Tribune Reporter April 16, 2008 Chuck Whitman runs an open-outcry trading pit. But unlike the floor at the Chicago Board of Trade, it exists only for training rookies at his firm. The real action breaks quickly across hundreds of computer screens, which fill a private trading floor the size of nine basketball courts, where his team invests the firm's money in derivatives ranging from U.S. Treasury bonds to crude oil. "I liked the idea of seeing all the markets at one time," Whitman said during a tour of Infinium Capital Management's month-old home. "And secondly, I could see the end of open-outcry coming." With the computer-led exodus of bodies from exchange floors, highly-secretive prop shops with untold billions of dollars are setting much of the agenda in Chicago's markets. Scattered across the city are more than 30 firms such as Infiniumâwhich trade options and futures with their own, proprietary fundsâand their relative anonymity belies their influence. These firms help bankroll the liquidity needed for 18.3 million contracts to flow daily through the Chicago Board Options Exchange and CME Group. The CBOE last month named a prop shop chief executive to its board. And two prop shops, Getco and Peak6, recently partnered with several of the world's premiere financial institutions to found an electronic exchange that would compete against the CME Group. "It's brought an amazing amount of value to the economy of Chicago," said Ben Londergan, co-CEO of Group One Trading and a new CBOE director. "Everyone would think Motorola is important to the economy of the area. I would argue that prop trading has played at least as important a role, particularly because it is centered here," he said. Prop shops do not solicit outside investors and consequentially avoid a lot of government regulation. At Infinium the practice trading pit, the turrets of computer monitors, the tin ceiling in the pub-style cafeteria all came from money belonging to its partners, but the extent of the profits remains unknown. "That's one I would rather not talk about," Whitman said. "One of the components of being a prop firm is that you don't have to disclose that." Because prop shops exist outside the public eye, few noticed their pivotal role in an era when open-outcry trading has dwindled, or, in the case of options, coupled to a computer in a hybrid model. As the CME Group consolidates all floor action on the Chicago Mercantile Exchange at the art deco CBOT skyscraper, many have wondered whether one less exchange floor could eventually squander the city's prestige. But several displaced floor traders moved to prop shops, said Stephen Dillinger, a managing member of the Cornerstone Trading Group. In addition to the half-dozen partners at Cornerstone, about two dozen former floor traders use the firm's offices to manage personal accounts. "You can't just go in the skybox and see a thousand traders," Dillinger said. "That doesn't mean they've gone. They've gone to different places like mine. The trading business is as strong as it's ever been. It's just evolved." The importance of prop shops can be explained with a gambling metaphor. In a pre-electronic era, exchanges were casinos that relied on the equivalent of plush carpets, complimentary beverages and lounge acts to lure gamblers, or traders. But when most trading volume became computerized the casino amenities mattered less. What the gamblers really wanted were top-notch dealers, or prop shops responsible for making the markets in different futures and options contracts. "The gambler will go to the dealer who gives them the best odds," said Ilya Talman, president and founder of Roy Talman & Associates, a recruiter in Chicago. "Now what makes the casinos are the dealers." Locals banded together Prop shops descended from "locals" who traded for their own accounts on exchange floors. They provided a market for the institutional brokers buying and selling customer orders. Some locals owned exchange seats. Others leased them. In some cases the locals banded together to better manage risks associated with trading, but they had transient careers and moved among those groups as free agents. Computers interrupted that natural order. As volumes surged in a digital age and hedge funds and investment banks entered the Chicago markets, market makers needed more capital to keep their positions. That drove locals into larger groups that became the modern-day prop shops, said Anthony Carone, the head risk manager at G-Bar Limited Partnership. The concentration of capital in a smaller collection of proprietary firms does present a challenge to the system. Instead of investment positions being spread among masses of locals, they might now reside within a handful of firms in which a chain of setbacks could pose a greater threat to the markets, said Phil Gocke, president of Brite Sky, an options trading company. Prop shops come in a variety of shapes and sizes. Some are "black box" units that trade algorithmically with customized software. Others rely on human intuition. "Gray box" firms, such as Infinium, do both. "If you're going to be employing a black box and take the trader out of it, you lose a lot of value," said Nathan Laurell, director of business development at Infinium. "The flip to it is if you don't have the technology, you can't compete." Computer equations can be written conservatively, but unlike traders they can't have skeptical attitudes, Laurell explained. Some prop shops are "arcades," which provide do-it-yourselfers market tips and a computer terminal. Others employ hundreds, have offices worldwide and occasionally break their silence to comment before the Securities and Exchange Commission. Gamblers sought Jump Trading's Web site lists eight openings. It seeks accountants, computer engineers and, most importantly, recruiters to develop "Jump's image as a highly sought after employer by identifying marketing and promotional opportunities for the firm such as social networking sites, blogs, and other venues." Wolverine Trading and Darwin Capital Trading recruit at the University of Chicago, which sends 15 to 20 students to prop shops each year. Prop firms began visiting campus about three years ago, said Meredith Daw, associate dean of students at the University of Chicago. "They really like students who have an interest in gaming, students who spend Saturday nights playing poker," Daw said. "They like students who are assertive, generally athletes," she said. "Athletes tend to work well as a team." Infinium has its roots with a junior high basketball squad in Des Plaines that Chuck Whitman coached in 1993, a year after he began trading soybeans at the Chicago Board of Trade. One of his players had a brother on the high school team, whom Whitman befriended. Brian Johnson eventually started as forward at the University of Illinois, taking a Big Ten championship in 1998 and an electrical engineering degree. "He's the kind of guy, I always joke, who could disappear with a laptop and cell phone and nobody would find him," Whitman said of Infinium's chief technology officer. Johnson had a summer internship at Motorola Inc. but several months at the Schaumburg-based cell phone-maker convinced him that the more intriguing innovations were in finance. Whitman and Johnson became partners. They approached the Hanley Group in 2001, proposing to take over its index and stock options division, which was renamed Infinium. The 175-person firm moved almost two miles away this month from the CBOT to the old Montgomery Ward catalog house, a concrete trapezoid hugging the Chicago River. When Chicago served as America's mail-order capital last century, Montgomery Ward warehoused items here such as blue chinchilla overcoats, cashmere women's hosiery and muff robes that warmed passengers in open-air automobiles. The third floor of the building now has whiteboards lining the walls, where Whitman plans to scribble the Xs and Os of moneymaking plays so that Infinium can hold meetings where everyone walks. He adapted this strategy from his experience in the open-outcry pits. "You learn better on your feet than sitting down," he said.